Effects of the Tax Cuts and Jobs Act on Real Estate

The Tax Cuts and Jobs Act was approved by Congress 12/20/2017. It will likely save many people on their final tax bill starting with the 2018 tax filings though some are going to benefit much greater than others.  The biggest gains are for businesses.  Since many real estate businesses and professionals work as independent contractors or as pass through owners these same tax benefits will be applicable.  The following stats and break down information was sourced from the National Association of Realtors.
All individual provisions are generally effective after December 31, 2017 for the 2018 tax filing year and expire on December 31, 2025 unless otherwise noted. The provisions do not affect tax filings for 2017 unless noted.  (Please note that I am not giving any specific tax advise.  This is a general break down with non-specific examples. You should contact a tax professional to find out how the new tax plan will affect your personal tax situation.)

Major Provisions Affecting Current and Prospective Homeowners

Tax Rate Reductions according to The Tax Cuts and Jobs Act

• The new law provides lower tax rates for most individual tax filers. Not every American will pay lower taxes under these changes, but the overall effect is more than $1.2 trillion in tax savings over the next ten years.
• The tax rate is divided into seven brackets with slightly lower marginal rates of 10%, 12%, 22%, 24%, 32%, 35%, and 37%.
• The Tax Cuts and Jobs Act retains the current-law maximum rates on net capital gains (generally, 15% maximum rate but 20% for those in the highest tax bracket; 25% rate on “recapture” of depreciation from real property).

Exclusion of Gain on Sale of a Principal Residence

•  The Tax Cuts and Jobs Act retains current law.

Mortgage Interest Deduction

• The Tax Cuts and Jobs Act reduces the limit on deductible mortgage debt to $750,000 for new loans taken out after 12/14/17. (Current loans of up to $1 million are grandfathered and are not subject to the new $750,000 cap.) Neither limit is indexed for inflation.
• Homeowners may refinance mortgage debts existing on 12/14/17 up to $1 million and still deduct the interest, so long as the new loan does not exceed the amount of the mortgage being refinanced.
• The Tax Cuts and Jobs Act repeals the deduction for interest paid on home equity debt through 12/31/25. Interest is still deductible on home equity loans (or second mortgages) if the proceeds are used to substantially improve the residence.
• Interest remains deductible on second homes, but subject to the $1 million / $750,000 limits.

Deduction for State and Local Taxes

• The Tax Cuts and Jobs Act allows an itemized deduction of up to $10,000 for the total of state and local property taxes and income or sales taxes.
• This $10,000 limit applies for both single and married filers and is not indexed for inflation.
• The Act also precludes the deduction of 2018 state and local income taxes prepaid in 2017.

Standard Deduction

• The Tax Cuts and Jobs Act provides a standard deduction of $12,000 for single individuals and $24,000 for joint returns. This is double the current standard deduction. The new standard deduction is indexed for inflation.

Repeal of Personal Exemptions

• Under the prior law, tax filers could deduct $4,150 in 2018 for the filer and his or her spouse, if any, and for each dependent.
• These exemptions have been repealed in the new law and replaced with a higher child tax credit.

Mortgage Credit Certificates (MCCs)

• Current law is retained

Deduction for Medical Expenses

• The deduction for medical expenses remains but is reduced to 7.5% from 10%

Child Credit

•  The Tax Cuts and Jobs Act increases child tax credit to $2,000 from $1,000 and keeps the age limit at 16 and younger.

Student Loan Interest Deduction

• The Tax Cuts and Jobs Act retains current law, allowing deductibility of student loan debt up to $2,500, subject to income phase-outs.

Deduction for Casualty Losses

• The Tax Cuts and Jobs Act provides a deduction only if a loss is attributable to a presidentially-declared disaster.

Moving Expenses

• The Tax Cuts and Jobs Act repeals moving expense deduction and exclusion, except for members of the Armed Forces.

Major Provisions Affecting Commercial Real Estate

Like-Kind Exchanges

• The Tax Cuts and Jobs Act retains the current Section 1031 Like Kind Exchange rules for real property. It repeals the use of Section 1031 for personal property, such as art work, auto fleets, heavy equipment, etc.

Carried Interest

• The Tax Cuts and Jobs Act requires a 3-year holding period to qualify for current-law (capital gains) treatment.

Cost Recovery (Depreciation)

• The Tax Cuts and Jobs Act retains the current recovery periods for nonresidential real property (39 years), residential rental property (27.5 years) and qualified improvements (15 years). The Act also replaces separate definitions for qualified Restaurant, Leasehold, and Retail improvements with one definition of “Qualified Improvement Property.”

Qualified Private Activity Bonds

• The Tax Cuts and Jobs Act retains deductions of qualified private activity bonds used in constructing affordable housing, local transportation and infrastructure projects and for state and local mortgage bond programs.

Low Income Housing Tax Credit

• The Tax Cuts and Jobs Act retains current law. However, a lower corporate rate will negatively impact the value of the credits in the future. This will result in less low-income housing being developed.

Rehabilitation Credit (Historic Tax Credit)

• The Tax Cuts and Jobs Act repeals the current-law 10% credit for pre-1936 buildings, but retains the current 20% credit for certified historic structures (but modified so the credit is allowable over a 5-year period based on a ratable share (20%) each year).

Major Provisions Affecting Real Estate Professionals

Deduction for Qualified Business Income

Because The Tax Cuts and Jobs Act greatly decreases the tax rate for corporations, the business income earned by sole proprietors, such as independent contractors, as well as by pass-through businesses, such as partnerships, limited liability companies (LLCs), and S corporations, will also receive tax rate reductions. In addition to lower marginal tax rates, the final bill provides a significant up-front (above the line) deduction of 20% for business income earned by many of these businesses, but with certain conditions.

• Specifically, the bill limits the 20% deduction to non-personal service businesses. Essentially, a personal service business is one involving the performance of services in the following fields:
• Health, Law, Consulting, Athletics, Financial Services, Brokerage Services (not real estate), and “Any business where the main asset of the business is the reputation or skill of one or more of its employees or owners.”
• It seems clear that most real estate agents and brokers will be considered in a personal service business and would thus not normally qualify for the 20% deduction.

However, many real estate professionals are able to take advantage of the deduction.

• This exception provides that if the business owner has taxable income of less than $157,500 (for single taxpayers) or $315,000 (for couples filing jointly), then the personal service restriction will not apply.
• Above this level of income, the benefit of the 20% deduction is phased out over an income range of $50,000 for singles and an income range of $100,000 for couples.
• For those with non-personal service incomeabove these thresholds, the bill provides a second exception that may still allow a full or limited 20% deduction. This second exception (the wage and capital limit exception)places a limit on the deduction of the greater of:
  • 50% of the W-2 wages paid by the business, or
  • The total of 25% of the W-2 wages paid by the business plus 2.5% of the cost basis of the tangible depreciable property of the business at the end of the year.

Bottom Line: Independent contractors and pass-through business owners with personal service income, including real estate agents and brokers, with taxable income below the $157,500 or $315,000 thresholds may generally claim the full 20% deduction under the personal service income exception. Independent contractors and pass-through business owners with non-personal service income and total taxable income below these thresholds may also claim the full 20% qualified business income deduction. In addition, independent contractors (or other sole proprietors) with non-personal service incomes above these thresholds may also be able to claim a 20% deduction, but that deduction may be limited by the wage and capital limit exception.

Section 179 Expenses

• The Tax Cuts and Jobs Act increases the amount of qualified property eligible for immediate expensing from $500,000 (current law) to $1 million. The phase-out limitations are increased from $2 million to $2.5 million.
• The Tax Cuts and Jobs Act expands the definition of qualified real property eligible for section 179 expensing to include any of the following improvements to nonresidential real property placed in service after the date such property was first placed in service: roofs; heating, ventilation, and air-conditioning property; fire protection and alarm systems; and security systems.
• The Act also significantly increases the amount of first-year depreciation that may be claimed on passenger automobiles used in business to $10,000 for the year in which the vehicle is placed in service, $16,000 for the second year, $9,600 for the third year, and $5,760 for the fourth and later years in the recovery period.

Denial of Deductibility of Entertainment Expenses

Prior to the Tax Cuts and Job Act, taxpayers generally could deduct 50% of expenses for business-related meals and entertainment. Meals provided to an employee for the convenience of the employer on the employer’s business premises were 100% deductible by the employer and tax-free to the recipient employee. Various other employer-provided fringe benefits were also deductible by the employer and tax-free to the recipient employee.

• The Tax Cuts and Job Act provides that no deduction is allowed with respect to:
  • An activity generally considered to be entertainment, amusement, or recreation;
  • Membership dues with respect to any club organized for business, pleasure, recreation or other social purpose, or
  • A facility or portion of a facility used in connection with the above items.
• Thus, the provision repeals the present-law exception to the deduction disallowance for entertainment, amusement, or recreation that is directly related to (or, in certain cases, associated with) the active conduct of the taxpayer’s trade or business.
• Taxpayers may still generally deduct 50 percent of the food and beverage expenses associated with operating their trade or business (e.g., meals consumed by employees on work travel).

Information was obtained from multiple sources including: The National Association of Realtors and the Tax Foundation